Better to Have a Fund Manager with an Ownership Stake?

As of 2005, the Securities and Exchange Commission requires most mutual funds “to disclose…each portfolio manager’s ownership of securities in the fund” using dollar ranges. Should investors favor funds in which the fund managers hold direct stakes? In other words, do funds with management ownership outperform? In their August 2006 paper entitled “Portfolio Manager Ownership and Fund Performance”, Ajay Khorana, Henri Servaes and Lei Wedge exploit the new data to test the relationship between fund manager ownership and fund performance. Using monthly return data for a sample of 1,406 mutual funds having ownership data available as of the end of December 2004, they find that:

• 43% of mutual fund managers have ownership stakes in their funds, with an average managerial stake of $97,000 (equating to 0.04% of assets under management).
• Fund manager ownership tends to be relatively high when: assets are stocks; past performance is strong; front-end loads are low; fund size is small; the fund family is small; and, manager tenure is long.
• Future risk-adjusted performance relates positively to managerial ownership, with performance improving by 3-5 basis points per month for each basis point of managerial ownership (as a percentage of fund size).
• Fund managers with ownership stakes have superior information about future fund performance, and/or ownership amplifies the incentives of managers to outperform.

In summary, mutual fund investors should favor funds having ownership stakes, which directly align managerial incentives with investor goals.

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